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Taxation of trusts (Offshore trusts can therefore be a useful way to…
Taxation of trusts
Offshore trusts can therefore be a useful way to reduce the level of IHT that is payable from a person's estate, providing the assets are gifted in a timely manner
For example if the assets were not held in a trust and were instead held by an individual, UK IHT would be due on the individual's death in respect of any UK assets and if the individual was deemed domiciled in the UK, IHT would be due in respect of their worldwide assets. Wealthy individuals can therefore reduce their IHT liability by giving away their assets
If an asset is given away, for example to an offshore trust, but an interest is kept in the asset (eg a settlor settles their house into the trust but continues to live in it rent free) then this gift if known as a gift with reservation and is not a PET. Such a gift would still form a part of the person's estate upon their death
Consideration should also be given to situations where a person makes a gift into a trust but continues to benefit from it. This would not only result in the payment of IHT on the transfer, but the gift would still count as part of that person's death estate
Specific types of trusts created on the death of the settlor as specified in their will, in which a specific beneficiary has a right to the current income of the trust (i.e a life tenant) are referred to as an interest in possession trust. According to HMRC and Schedule 20 of the Finance Act 2006, this has different IHT implications from a normal trust. On the death of the life tenant this would form part of the death estate of the life tenant. During their lifetime, transfers of value from the trust to the life tenant do not incur IHT, but transfers to other individuals (with the exemption of spouses and civil partners) would be treated as a PET
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Flee clauses
In recent years, changes to tax regimes have become more frequent. These changes may occur in the offshore jurisdictions where the assets have been placed or where the settlor, beneficiary or beneficial owners reside and/or are domicile
As, on occasions, any resultant change in the tax regime could have had a negative impact on the client and incur additional tax, a 'flee clause' may not be added to the standard documentation signed by the client
This clause enable the 'affairs of the client' to be moved to a different jurisdiction maintaining the current tax planning advantages for that client
'Relevant Property' represents most assets that can be transferred into a trust. This can include property, shares and money. These may incur an IHT liability when they are transferred out of the trust, referred to as an exit charge or on the tenth anniversary of the trust
There are exemptions, which includes when Relevant Property is placed into an interest-in-possession trust on the death of the person or when proper is set aside for a disabled person or minor
Trustees are responsible for declaring and paying income tax on income received by the trust. They currently do this in the UK using form SA900 Trust and Estate Tax Return each year
In both discretionary trusts and accumulation trusts, income is taxed at the special trust rates, apart from the first £1,000 of trust income, which is known as the 'standard rate band'
Income that falls within the standard rate band is taxed at lower rates, depending on the nature of the income. This is a complicated area of trust taxation and special tax rules apply to interest in possession trusts with beneficiaries who are disabled or who are children who have lost a parent through death
IHT for trusts is dependent upon the type of trust as well as the assets that have been settled into that trust
Some property is also considered to be 'Excluded' resulting in that property being exempt from the effects of IHT. The most common of these are either government securities or property situated outside of the UK
Most types of trust in the UK, such as discretionary trusts, are considered to be relevant property trusts for the purposes of IHT. On either the creation of the trust or the gifting of any assets into it during the settlor's lifetime, gifts are taxed at half of the normal IHT death rate that would be payable
If the settlor dies within seven years of the settlement, then the previous charge is recalculated as though it were a PET. This can result in more tax being required to be paid, as the recalculation is undertaken using the full amount of IHT that would normally be due